How To Allow Your Children To Retire Young

As a parent, would you like your child to be able to consider retiring when he will be 35? I definitely would and you can bet your kid, if properly financially educated, can attain such an incredible result and be forever grateful to his thrifty mom or dad.

My father was a respectable person but was very conservative with money and never invested in the stock market, preferring to lay his salary aside in safe government bonds.

I now live decently, my house is fully paid for, I can afford holidays regularly and even buy stuff on a whim, but I am required to spend at least another couple of decades at my working place before I can call it quits. Unfortunately I became interested in the stock market only when I was 25, and it took me quite some time to learn what little I know now, losing meaningful sums of money in the process.

So I sometimes fancy how things could have been different if my father decided to hoard away some of his wages each year and invest them for me in the stock market every following January since I was born. It would have been even better had he presented me with a copy of Ben Graham's The Intelligent Investor for my 10th birthday, instead of the 1985 edition of The Guinness Book of Records.

Let's imagine a really simple investing plan, starting January 1, 1975 when I was just 7 months old, and lasting twenty years, through January 1994. Let's also imagine he just picked one stock for my portfolio, Disney (NYSE:DIS). Let's make modest investments; reasonable figures for the time would be $500 a year from 1975 to 1979, $1000 a year from 1980 to 1984, $1500 from 1985 to 1989 and $2000 from 1990 to 1994. Dividends would be collected and not reinvested at the time of payment.

Let's see how things would have turned out:

$ 500 investments, made on the first trading day of the year:

Year

DIS Closing Price

Shares Bought

1975

30

16

1976

60

8

1977

41

12

1978

33

15

1979

41

12

Total shares 1975 - 1979 : 63

-----$ 1000 investments, made on the first trading day of the year:

Year

DIS Closing Price

Shares Bought

1980

47

21

1981

52

19

1982

50

20

1983

67

14

1984

56

17

Total shares 1975 - 1984: 154

-----$ 1500 investments, made on the first trading day of the year:

Year

DIS Closing Price

Shares Bought

1985

74

20

1986

118

12

In march 1986 the stock split 4:1 so our total 186 shares bought so far now become 744 - let's go on

Year

DIS Closing Price

Shares Bought

1987

56

26

1988

58

25

1989

75

20

Total shares 1975 - 1989: 815

-----$ 2000investments, made on the first trading day of the year:

Year

DIS Closing Price

Shares Bought

1990

104

19

1991

108

18

1992

136

14

In may 1992 the stock split again 4:1 so our total 866 shares bought so far become 3464

Year

DIS Closing Price

Shares Bought

1993

46

43

1994

51

39

Total shares 1975 - 1994: 3,546

That's it. Now my father would have stopped buying shares for me and proceeded to transfer them into my bank account. In January 1994, five months ahead of my 20th birthday, I'd already be quite rich, because my Disney shares are worth almost $ 180,000. In July 1994 I began working as a government employee. If I then was financially savvy and decided to squirrel my shares away living off my wages and dividends, by the time I was 35 the following would have happened:

From February 1994 to May 2009 I would have collected about $31,000 in dividends.

I could have then realized that Disney was not a great dividend player, so at the ripe age of 35 I would have changed my portfolio allocation into that of a wanna-be-retiree, that is, I'd turn into a dividend growth investor. With almost $300,000 to allocate I could easily build a safe portfolio that netted me about $900 a month from day one and retire to South America, never having to work another day in my life, if I chose to. And, as I've shown in my previous article, you can expect that $900 to slowly grow to the rate of $1 each week. Remember: all this without me ever adding a cent to the portfolio and spending all my wages between 1994 and 2009; this all thanks to the few thousand dollars invested yearly by my father from 1975 to 1994.

Yet I would have probably known better, and had I chosen to keep adding another $3,000 a year in Disney from 1995 to Jan 2009, with most of that money covered just by the dividends, on my 35th birthday I would have owned about 13,000 shares for a total net worth of $325,000.

Now you could contend that I cherry picked Disney to make my case. Well, not. Had I chosen Coke (NYSE:KO), McDonald's (NYSE:MCD), Johnson and Johnson's (NYSE:JNJ) or IBM (NYSE:IBM) the results would have been similar, if we include dividends in our total return. Actually, with McDonald's it would have been noticeably better because from 1975 onwards, the Big Mac outperformed Mickey Mouse by more than 40%.

The point is, I picked Disney to prove how, given enough time, even modest, regular investments can turn into large heaps of cash. When asked to nominate the most powerful force on earth, Albert Einstein is reputed to have answered "compound interest"; Buffett might well agree.

Stocks on average are expected to return 7% a year adjusted for inflation, including dividends. That is why, as soon as my son was born in July 2011, I instructed my broker to automatically invest for him a total of $200 a month split among three ETFs: a broad developed markets fund (40% allocation), a broad emerging markets fund (30%) and a global real estate fund (30%). (As a side note, my Italian broker provides for automatic monthly ETF investment plans.)

The future value of money is a key concept that illuminates the path toward financial prosperity. You should think of cash as a seed, and if you sow it instead of eating it, it will grow accordingly to the following formula:

FV = PV * (1+r)^p

where FV is the future value of our investment, PV is the current invested amount, r is the rate of growth and p is the time in years we keep the money invested. Since we are making regular monthly contributions, the formula is a more complicated (if you want to learn the maths behind it take a look at this Wikipedia article), but thanks to the power of compound interest, our investments will grow to about $105,000 by the end of 2032, and that is already adjusted for inflation. Of course, if we decide to increase our monthly contributions over the years, the end result will be higher.

Now, our 20 year old has already a meaningful sum to invest and with proper education and an adequate income stream can reasonably start making plans to retire by the time he blows his 35th candle on the cake. In fact he can choose to invest the dividends from his $105,000 portfolio and then some of his salary if he is already working part-time while studying. With little effort he would be able to save $500 a month, that assuming a 7% rate again, would grow to $161,000 in 15 years. If we let them ripen another 5 years, still adding $500 a month, we easily pass the $260,000 mark, plus the $105,000 we already had set apart. That is, at age 40 our son has a stock portfolio that is worth about $365,000, and what is most important is that this result is within the grasp of most of us: all it takes is determination, $200 a month and a financially savvy family.

Note: All I set forth is based in part on historical data and in part on statistics. Keep this in mind before challenging my assumptions. Anything can happen. The next depression could be around the corner , capitalism could cease to exist or another economic boom could be in the cards. Financial planning without statistic assumptions would be utterly pointless.

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